In this paper, I present a theory of dynamic economic growth, business cycles, and asset pricing that integrates (1) Marx's idea (and emphasized by Klein) of a two-class heterogeneity of the ownership structure of physical capital and human capital in a capitalist society, (2) Keynes' idea of sticky wages, and (3) the existence of a competitive equilibrium with intertemporal consumption and portfolio decisions by risk-averse capitalists facing a contractual labor cost.
The aggregate labor income as a function of recent history of aggregate outputs is determined by the prevailing mode of income distribution. I focus on a modern capitalist economy in which the income distribution is not dictated by the capitalists (as in the formative years of capitalism which was the subject of inquiry by Adam Smith, David Ricardo, and Karl Max), but rather is determined by the economic and political consensus reached between the capitalists and workers through a legal and political framework featuring strong labor unions, anti-trust laws, and progressive tax codes.
Three main implications for the macro-economy are presented. First, my theory endogenizes completely the three-equation Klein model of consumption function, savings function, and the wage demand function. Second, I show that cyclic behavior is driven entirely by the assumed form of income distribution. Production and labor income shocks do not drive, but help sustain the cyclic behavior by preventing the economy from converging to the steady state mean. Third, I show that the Marxian doctrine that the "rate of surplus value" remains constant and the "organic composition of capital" keeps rising is inconsistent with the predictions of my model, and the difference is traced to the different assumptions on income distribution, and leads to different conclusions on the stability of capitalist economies.
By assuming that capital markets clear in equilibrium, I determine the risk premium for both production and labor income risks, and consequently asset returns and the value of human capital - all endogenously. A special case of the model is observationally equivalent to the stochastic habit formation model of Dai (2000), and thus inherits its ability to simultaneously explain the equity premium puzzle, riskless rate puzzle, and the expectations puzzle. In general, the labor market need not clear, due to the only friction in the model: the longevity of the labor contract.
From Equity Premium Puzzle to Expectations Puzzle: A General Equilibrium Production Economy with Stochastic Habit Formation

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